Flood of Russian diesel puts European refiners under pressure

Russia's slowing domestic economy is leading to a flood of Russian diesel exports flowing toward Europe, which could soon force a new round of European refinery closures.

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By JENNY GROSS

LONDON -- Russia's slowing economy is leading to a flood of
Russian diesel flowing to Europe, which could force a new round
of European refinery closures.

Europe's refineries -- which turn crude oil into products
such as gasoline and diesel -- are already under pressure as
the continent's weak economy reduces demand for their output,
dragging down prices and reducing profit.

Such pressure
has already resulted in at least 16 refineries in the region
shutting crude capacity or indicating they plan to do so since
2008, and now diesel profits are being squeezed further by the
influx of Russian fuel.

Russia's Baltic Sea exports of diesel to northwest Europe have risen to nearly
500,000 bpd from 300,000 at the same time last year,
according to ESAI Energy, an energy consultancy.

The rise in exports comes as Russia's economy weakens with a
subsequent lower demand for the country's commodities, and
analysts expect the export trend to continue as Russian
refiners look to sell their diesel abroad to make up for the
waning domestic demand.

The flood of fuel comes as weak demand weighs on the price
of diesel, which is trading at $865.75/ton compared with
$946/ton this time last year, and reduces refiners' profit
margins. Refiners make about $14.83 refining a barrel of diesel compared
with $17.10 a barrel a year ago, according to an analysis by
The Wall Street Journal.

While the profit refiners still make on diesel may look
healthy, the refiners need to earn as much as possible from
diesel because profit from the fuel typically offsets losses on
other products.

"The more diesel that comes in from external suppliers, the
shakier the ground is for the most vulnerable refiners," Mr.
Reed said. This year will be much less profitable than 2012, he
said, and 2014 will be markedly worse.

Recent investment in Russian refineries has improved their
capacity and is allowing Russian diesel to be supplied directly
to the European market, whereas previously its exports needed
treatment before meeting European diesel standards, according
to a report published earlier this month by UKPIA, a trade
group representing refining in Britain.

Russian refiners are unlikely to reduce production in line
with local demand because the country's oil export duty gives
refineries an incentive to refine as much product as
possible.

Massimo Vacca, head of investor relations at Saras, one of
Italy's biggest oil refiners by capacity, said the company
would watch closely to see if the increase in exports from
Russia would lead to weaker diesel margins.

But he said this would be difficult to ascertain in the
coming months, because diesel margins typically fall in the
summer when there is lower need for heating fuel.

"Demand is on a downward slope and imports are on the rise
overall," Mr. Vacca said. "Whether diesel is coming from one
end or the other, it doesn't make a difference: The point is
European refiners are under pressure. They're faced with one of
two choices--close down or invest."

Saras SpA in March reported a net loss of 90.1 million euros
($116.5 million) for 2012, partly because of lower refining margins.

Lower demand because of fissures in the European economy has
already led to refinery closures across the region.
Swiss-based Petroplus filed insolvency in 2012, leading to
the temporary or full closures of its Antwerp plant, the Petit
Couronne refinery in France and the Swiss Cressier refinery,
after falling demand meant it could no longer finance
operations.

LyondellBasell has also reduced capacity, mothballing its
105,000 bpd Berre refinery in France in 2012 because of
low demand for products in the region and rising competition
from refiners in the Middle East and Asia, which cut into its
profits.

In total, recent closures have eliminated 1.6 million bbl of
crude distillation capacity -- about 10%
of total 2008 capacity in European Organization for Economic
Cooperation and Development countries capacity -- according to
ESAI.

"There's a lot more diesel moving around than there has
been," said Gemma Parker, downstream consultant at Facts Global
Energy. She said refineries in northwest Europe, where most of
the Russian Black Sea exports are headed, are most likely to be
hit.

To be sure, Europe does need to import diesel to meet
demand.

Many refineries in Europe were built decades ago and are
geared toward producing more gasoline, rather than
more-economical diesel, for which there is now higher
demand.

As a result, Europe demands more diesel than its refiners
can provide, meaning it depends on some diesel imports from
Russia and the Middle East to keep vehicles and industry
running. European cars are geared toward
diesel, while cars in the US tend to operate most efficiently
on gasoline.

However, the increase in diesel exports from Russia comes
just as Saudi Aramco ramps up its refining capacity to produce more
diesel and gasoline, meaning the global market is awash with
fuel.

The International Energy Agency said in a report published
May 14 that global refinery runs, or volume of oil
products produced by refineries, will jump by an unusually
steep 3.6 million bpd from April to August, from 75.1 million
bpd in the first quarter of 2013, boosted partly by new
capacity from Saudi Arabia.

European refiners are also being hit in the gasoline market,
says Jason Gammel, head of oil and gas research at Macquarie,
who said US refiners have significantly increased exports of
gasoline over the past few years.